EU tightens the regulatory net for digital companies

The wind is changing

Shares

The European Union (EU) has recently turned its attention to the thriving European digital economy, seeking to increase levels of regulation and impose new obligations on digital and technology companies, particularly in the areas of data protection and tax. Global law firm Reed Smith explores the effects of the proposed regulations and considers whether implementation will stifle innovation.

Data protection reforms

The EU is now looking to reform data protection law, but, while the train has left the station, its precise arrival time (and destination) is less clear.

The European Parliament has approved a draft General Data Protection Regulation and law enforcement Directive, and has pronounced itself ready to negotiate with the Council and the Commission, aiming for agreement on the final law by May 2014, before the EU parliamentary elections.

However, the Council does not appear entirely united on this timeframe. David Cameron is reportedly in favour of waiting until 2015 to finalise the law, in order to "get it right" and, after the latest revelations of NSA spying on EU state leaders, there might be some risk of the EU passing reactionary legislation in this area in haste.

Even before details of the NSA's surveillance activities in the EU became known, the reforms represented a challenging package for digital and technology companies in the EU, particularly SMEs.

EU Commissioner Reding made much of the reduction in red tape which the reforms would offer businesses (such as, removing registration requirements and introducing a regulatory "one stop shop"); however, we consider that the proposed law poses problems for technology companies and is unlikely to result in cost savings.

The draft regulations raise the bar on obtaining individuals' consent which must be an explicit indication, a genuine, free and reversible choice. Most challengingly, the provision of a service cannot be made conditional on an individual consenting to the processing of more of his/her data than is needed for the contract.

Profiling is to become specifically regulated, which could have implications for online behavioural advertising or differential pricing. Individuals also have reinforced rights to call for the erasure and rectification of their data, which means a company will need to pass on that request to any party to which it transferred the data, unless to do so is disproportionate.

Finally, there are plans to increase restrictions on flows of data outside the EU, which is already a compliance minefield under the existing data protection regime, and to bring in compulsory reporting of data security breaches. Punitive fines of the greater of Euros 100m or 5% of global annual turnover are currently being proposed.

Tax reforms

Over the last couple of years, there has been an increasing recognition that global digital companies are able, within the law, to structure themselves in a way which does not adequately tax their profits in the countries where they operate.

In October, the French Government proposed a new "digital tax" to the European Commission, with the intention of making non-EU internet companies pay taxes in the EU based on profits earned there.

The French proposal aims to link the tax base of international internet companies to the jurisdiction in which profits are earned, in order to prevent companies from shifting profits to lower tax regions. Revenues from the new tax would then be allocated among the EU member states.

However, we consider the French proposal to be a step in the wrong direction. Base erosion and profit shifting is a global issue which needs to be addressed at a global level. If the EU were to impose their own rules in isolation, this would discourage businesses from starting or continuing to operate in the EU.

The Organisation for Economic Co-operation and Development (OECD) is currently reviewing the taxation of the digital economy, and is set to deliver its findings within the next 18 months. All countries should support this OECD initiative, since it provides the best chance of a global solution – even if any such solution is likely to take several years to materialise.

Any new pan-EU tax would require the unanimous approval of all 28 member states before being introduced. However, the French digital tax proposal lacks the backing of a number of EU member states, including the UK.

The concern is that France will nevertheless seek to implement its proposal in supporting member states, using the enhanced co-operation procedure. That procedure is currently being used by 11 member states (including France) to introduce a financial transaction tax (FTT).

The legality of the FTT is being questioned because it has been drafted in a way which seeks to extend its scope beyond the jurisdiction of those member states implementing it, and yet without that extended scope the tax would be of limited effect. It is to be hoped that France learns from the FTT experience and does not push ahead with its digital tax proposal.

Conclusion

According to research by Belgium's Vlerick Business School, Europe currently has the potential to generate at least 400,000 extra jobs in the EU digital economy.

There is an argument that the EU should adopt light touch, rather than draconian, legislation to achieve this. It is a truism that legislation constantly plays a losing game of catch up with technology, and nowhere is this truer than for data, technology and digital content. However, to incentivise innovation, EU legislators should adopt a balanced approach designed to spur growth.